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Can Cabletron create a comeback?
By Vanessa Richardson
Redherring.com
September 24, 1999
With networking giants like Cisco Systems (Nasdaq: CSCO) and Nortel Networks (NYSE: NT) looming large, it's been hard for a small fry like Cabletron (NYSE: CS) to hold its ground. That may be changing now as the fifth-largest data networker attempts to prove that it has hit rock bottom, with nowhere to go but up.
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On Tuesday, the Rochester, New Hampshire-based company released its earnings for the second quarter of its fiscal 2000 year, ended August 31, which beat analysts' estimates for the second time in a row. Net income nearly doubled to $13 million, or seven cents a share, from $6.7 million, or four cents a share, in the second quarter of fiscal 1999. Revenues fell 3.8 percent to $356.6 million from $370.6 million as sales of older products slipped, but Cabletron stated that revenues for its latest device, the SmartSwitch Router, are growing 200 percent year-over-year.
Based on those figures, three of the 30 Cabletron analysts, who had expected earnings of only six cents a share, quickly revised their 2000 and 2001 fiscal-year earnings forecasts upward to reflect what they expect to be solid growth.
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"I think this was their last bad quarter and that they're bouncing up from the bottom," says SunTrust Equitable Securities (NYSE: STI) analyst William Becklean. Mr. Becklean upgraded his rating on Cabletron to Strong Buy last Friday.
BACK ON TRACK?
Cabletron has a long way to go, however. The stock closed Wednesday at $16.81 -- down $2.31 since its earnings announcement, but up 94 percent since the beginning of the year. Its share price, however, is still down 62 percent from its all-time high of $44.50 in May 1997.
Cabletron's fortunes then started to decline because of its slow adaptation to making high-speed switching devices. By the time the company realized its mistake and started acquiring in 1998 in order to round out its product line, it was too late. Cisco, Nortel, 3Com (Nasdaq: COMS), and Lucent Technologies (NYSE: LU) had swooped in, leaving Cabletron with less than 10 percent of the market.
New CEO Piyush Patel vows to prove everyone wrong and bring Cabletron back from the dumps. "This is a fundamentally different company today than it was six months ago," he stated during the earnings announcement. "We have a clear direction, we are focused on our direction, and we now have clear visibility."
Since his promotion from senior vice president of worldwide engineering in June, Mr. Patel has been pushing a three-pronged strategy. First, he's switching Cabletron's main focus to the hot Internet service provider market and pushing new products such as the SmartSwitch Router for high-speed Internet access. Second, he wants to grow revenues from Cabletron's overlooked services division to corporations. And third, he's pushing Cabletron to develop products for the emerging markets of wireless network and Internet telephony.
Will it work? So far, analysts have been giving him good marks on his enthusiasm, which seems to have spread elsewhere. "Businesses are responding to the new management, and the Cabletron staff are getting juiced up," says Ferris Baker Watts analyst Matthew Robison, who just started Cabletron coverage with a Strong Buy. "The first important thing Patel needed to do was boost employee morale, and he succeeded."
As for new products, Cabletron introduced its offerings for wireless and IP networks last week at the Network+Interop Show in Atlanta. Mr. Becklean thinks the company will have takers. "Cabletron has always had a reputation for providing good stuff, and corporate IT staff have ranked them high on their lists of suppliers," Mr. Becklean says.
WHOA, THERE!
Mr. Patel may be jumping ahead of himself, however, with his expectations for Cabletron's long-term growth. At technology conferences this summer, he stated that he wants annual revenue growth to bounce back to 30 to 40 percent within 18 months and the services business to grow at or above the industry average of 35 percent.
Even his strongest supporters on Wall Street are taking a cautious stance. Mr. Becklean tries to look on the bright side. "Well, their services organization is large and well-respected, and since Cabletron never thought of it as a profit center ... it may be possible to pump that up," he surmises.
Hambrecht & Quist (NYSE: HQ) analyst Erik Suppiger in New York, who gives a Buy rating, is less optimistic. "Services revenue did show growth last quarter, but I don't think it will generate as much as Patel expects," Mr. Suppiger says.
SILVER LININGS
Bounce-backs come with ups and downs, as Cabletron is finding out -- most recently in a new deal it made with Compaq (NYSE: CPQ), announced at the same time as second-quarter earnings. The good news: the PC manufacturer will make a multimillion-dollar equity investment in Cabletron's Spectrum software unit. The bad news: in exchange, Compaq will cancel a previous deal to buy $300 million a year in networking equipment and resell it under the Compaq brand.
Yet again analysts are upbeat, saying that the $55 million in lost quarterly revenue can be made up. Mr. Suppiger is reducing his revenue estimates from Compaq by $20 million in the upcoming third quarter, but states that the overall loss will only be incrementally negative. "Revenue may be lower through that channel, but overall margins are higher now that Cabletron can directly sell those components without Compaq as the middleman," he says.
Other bright patches through the clouds include spin-offs of Cabletron divisions. The stock leaped up in the spring when the Spectrum unit was expected to go out, but the deal was delayed by June's management change. Now analysts expect a Spectrum spin-off within the six next months. Also, Mr. Patel stated on Tuesday that he's considering doing the same with Cabletron's growing digital subscriber line (DSL) equipment business, which brought in $20 million in revenues for the first two quarters of fiscal year 2000. The decision will be influenced by how the DSL unit performs for the rest of fiscal year 2000, but since newly public competitors Redback Networks (Nasdaq: RBAK) and Copper Mountain (Nasdaq: CMTN) were warmly embraced at their initial public offerings, analysts expect Cabletron to follow through.
Despite the improved prospects for Cabletron, analysts are unanimous in what will ultimately befall the data networker -- death by acquisition. "Oh, definitely, Cabletron will be bought out," says Mr. Suppiger. "The question is when." Nokia (NYSE: NOK) and Ericsson (Nasdaq: ERICY) have been cited regularly as prospective buyers, since they're two of the last global wireless companies without data networking divisions.
Even Mr. Patel said this summer that he'll consider an offer when the right one comes along. With the brightening long-term outlook, though, he may hold out for a while. "I don't see any imminent transaction right now," concluded Mr. Becklean. "But while Cabletron is building itself back up, at the same time it's also improving its currency as an acquisition candidate." |
